Typically, regulators of monopoly utilities set the cost of debt and equity to work out how much it will cost the utilities to build infrastructure. This is a crucial factor to work out their earnings and ultimately a major determinant of the prices the networks can pass on to customers.

But as the cost of capital has fallen and a new regulatory period looms, networks are worried the present methodology will see capital costs locked in for five years.

Network operators now agree there should be several different methods to choose from to calculate debt and equity. At present, the Australian Energy Regulator uses an “on the day" approach to calculate the cost of debt, which means to match the rate, networks would have to raise all their debt for the full five-year regulatory period at one time.

This is rarely possible, and even if it were it would be too risky to do so as a network operator’s entire debt would be due for refinancing at the same time.

In a submission to the AER, peak body the Energy Networks Association agreed there were two new methods that had emerged as well as the “on the day" approach, but these need to be refined as part of the process. It favoured including the use of a “trailing average" of the cost of debt in the calculations over a number of years leading up to the new regulatory period.

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“[But] this is really just one method to move away from the volatile spot rate approach that has been used to date," ENA acting chief executive officer Bill Nagle told CFO. “Trailing average is looking at the history, but we also argue that the regulator needs to be able to look forward as well."

But he said using long-term bond rates may not be appropriate because there aren’t many Australian network operators and the rate they can borrow at may not fit this benchmark.

Victorian network operator,
SP AusNet
, said the regulator should determine the allowed cost of debt using the “methodology commensurate with the debt-management strategy an efficient network service provider would employ".

For it, and most other private networks, that involves staggering debt issuance, and taking out hedges over the five-year regulatory period to match the base interest rate with the rate set at the beginning of the period.

Most Australian energy regulators also use just one methodology to calculate the cost of equity – the Sharpe-Lintner capital asset pricing model (CAPM). But many other methodologies have arisen.

“The ENA considers that the guidelines development process should examine the use of at least the Sharpe-Lintner CAPM, the Black CAPM, the Fama French Methodology, dividend growth models and other relevant evidence," it wrote in its submission to the AER.